**This is a simplified explanation to introduce new traders to Stop Losses and why they should be implemented.**
“I am a trader! I have done my research on specific stocks, I know that the company has decent funds set aside for rainy days/months (or years if required), more so than a lot of their competitors, and I don’t trade with Stop Losses as I know my analysis is good.”
I am aware of a few people that think like this and trust their research. Yes, it can work in your favour but as nobody knows what is around the corner, it is tantamount to gambling.
Another reason some don’t use Stop Losses is based on psychology. Basically, you see your stock go up in price (great feeling), and then after a while, you see it slowly start to come down. You know that almost all stocks are falling, maybe due to some unforeseen event and one begins to get that paralysed feeling. You know the company is financially strong and just hold on to “ride the storm” as you know that it will eventually come back to where it was… If you are one of these, you are not alone as there are quite a few people that do this… Truth be told, I have also been this person and I must admit, in this industry, there is nothing worse than feeling helpless whilst watching your hard-earned money plummeting down.
“But Gio, it’s ok, right, as my stock is now riding pretty again so no biggie in the end”… Ok good, you have come into profit again, which is great as at the end of the day, that’s what all this is about
BUT what if there was a way to be in the same stock and actually be EVEN MORE PROFITABLE at this point!
Let’s use Astrazeneca as an Example stock: Astrazeneca – Ticker: AZN
Buy in Price 7625 on 28/10/2019
Price today 8756 24/08/2020
That is a healthy rise of 1131 – Yes, that is profitable, which is good, right?
Now let’s try again, this time with a Stop Loss
Buy in Price 7625 on 28th October 2019
(stop loss set at 10%)
Price gets stopped out at 6862… (stopped out basically means, it went down and the Stop Loss kicked in.) Price actually dropped to 5993 because of covid19 dip
You buy back in at 6578… (you didn’t buy back in at 6500 as you wanted to make sure that the price was still pushing up) You could have actually bought back in a lot earlier, maybe 6200 or 6300 but I purposely chose a higher buy in as though it actually means less profits, it still shows how profitable it is.
Price is 8756 today.
How does this equate?
1, You bought in at 7625
2, Stop Loss kicked in at 6862
So far, you are down 763
3, You bought back in at 6578
Price today is 8756
So this means todays price (8756) minus our bought back in price (6578) minus our original loss (763)
This now totals 1415 which is 284 MORE than if you didn’t use a Stop Loss, from the original example.
Granted, in the scheme of things, some may think, “that’s no biggie”, but if you are investing and have a few stocks and shares you are working with, then this all adds up to some serious money that you have missed out on.
There is one more thing to mention that may actually hurt a little more, so I left it until this point… (sorry)
In the above example, we are assuming that 1 share of Astrazeneca was bought for 7625, so our initial loss would have been 284 over the long run. Now imagine if you had bought 10! That would turn our extra gain from 284 to 2840!! Or, to make it sound bad, we would have lost out on an extra 2840… And if you did similar across 10 different stocks, yes, you’d still be in profit, but the extra money you could have had, just for setting up Stop Losses, doesn’t even bare thinking about! (well, actually it does bear thinking about. VERY MUCH SO!)
In this article, the stop loss was set to 10%, but please don’t take this as the right place or percentage to set a Stop Loss as they need to be individually calculated. Not all Stop Losses are the same.
Some people see Stop Losses almost as a failure, “Maybe I haven’t done enough due diligence on my chosen stock”, or, “I must have missed something. I won’t let that happen again”… This is like saying that one has failed in some way but this is NOT TRUE.
Don’t ever see a Stop Loss as a failure or that it is only needed in case you made a mistake. A Stop Loss (notice how I keep typing “Stop Loss” with a capital first letter, as it really is that important) is OUR SAVIOUR!… (ok, may be overdoing it on the nerd factor).. It is our safety net so that we can trade, but there to catch us if the market decides to start playing “Silly Buggers” with us
One more thing to remember about using properly calculated Stop Losses is that they take out the emotions from investing. This is actually very important to bear in mind. We are not here to get attached to a share; we are here to make money. The moment emotions start getting in the way, then you are switching from your brain making decisions, to your heart, and in this industry, that just doesn’t work. A Stop Loss doesn’t care, it is there to protect you. It sees the price go lower and just kicks in, saving your funds from getting even more depleted.
I have put a screenshot of Astrazeneca within this write up so as to show when it dipped. Some may say that Covid19 happened before that dip in the chart, and you’d be right. But this is a major pharmaceutical and it takes a while for the ripples to hit them. Besides, during a pandemic, quite a few would have jumped on board with drug companies, so the above hit would have been a lot worse for many others and one may have lost a lot more.
Bottom line is, if you are doing this to make money, then I would strongly recommend understanding Stop Losses and how to use them, as this alone can seriously help your account grow.
Mastering this (and a few other techniques), will genuinely help you achieve much higher profits and make more money, as bear in mind that having a few losing trades every now and then is part and parcel of what we do, the trick is to know when to cut out from a losing trade so that we can concentrate on our winning trades.
The way I see it, a well-placed Stop Loss means that though I may lose a battle, I have not lost the war, and still have more than enough resources left to step back up to the plate <– (not sure why I chose this one, but hey)
If you haven’t fallen asleep yet, then I hope this has helped give some of the newer members, a basic understanding of a Stop Loss and what they are used for.